A Rig-Driven Rally for Oilfield Services

Summary:
Does the recent stabilization in oil prices portend better times ahead for energy companies? Investors in oilfield services companies (OFS), which provide equipment and support to exploration and production companies, certainly think so, as evidenced by the fact that the stocks of several such companies up by double-digit percentages this year. Can the rally continue? Equity strategists from Credit Suisse’s Global Markets team think so.
Why? The answer lies in a single number: the oil rig count. When oil prices began their slide in the summer of 2014, U.S. drillers stayed optimistic, and continued sending new oil rigs out into the oil patch. That October, the number of active rigs dotting American oil fields reached a record 1,609, according to energy services firm Baker Hughes. But the deep and prolonged decline in energy prices ultimately made it uneconomic to keep many of the rigs in operation, and the number of active rigs eventually shrank to a low of 404 in May 2016—less than a quarter of its one-time high.
OFS firms, which provide the technology and data critical to identifying promising drilling sites and the equipment used on the rigs themselves, saw their business evaporate along with the rig counts. The VanEck Vectors Oil Services ETF, which tracks the value of 25 of the largest U.S.-listed OFS firms, lost nearly 24 percent in 2014 and another 26 percent in 2015.

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Does the recent stabilization in oil prices portend better times ahead for energy companies? Investors in oilfield services companies (OFS), which provide equipment and support to exploration and production companies, certainly think so, as evidenced by the fact that the stocks of several such companies up by double-digit percentages this year. Can the rally continue? Equity strategists from Credit Suisse’s Global Markets team think so.

Why? The answer lies in a single number: the oil rig count. When oil prices began their slide in the summer of 2014, U.S. drillers stayed optimistic, and continued sending new oil rigs out into the oil patch. That October, the number of active rigs dotting American oil fields reached a record 1,609, according to energy services firm Baker Hughes. But the deep and prolonged decline in energy prices ultimately made it uneconomic to keep many of the rigs in operation, and the number of active rigs eventually shrank to a low of 404 in May 2016—less than a quarter of its one-time high.

OFS firms, which provide the technology and data critical to identifying promising drilling sites and the equipment used on the rigs themselves, saw their business evaporate along with the rig counts. The VanEck Vectors Oil Services ETF, which tracks the value of 25 of the largest U.S.-listed OFS firms, lost nearly 24 percent in 2014 and another 26 percent in 2015. But that’s where many investors decided to call the bottom. The VanEck ETF began to rebound in February and was up more than 11 percent for the year through mid-August, with the stocks of some OFS companies up more than 20 percent. If that sounds like an opportunity missed, it’s only half of one: According to Credit Suisse strategists, the historical relationship between rig counts and stock performance suggests that OFS shares will continue outperforming for months to come.

In analyzing how OFS stocks fared before and after 13 historical rig count troughs dating back to the mid-1970s, the strategists determined that investors typically don’t wait for the troughs to become obvious before plowing money into OFS companies. Indeed, OFS stocks have typically already risen 33 percent off their lows by the time oil rig counts hit their actual trough. (This being clear in retrospect, not as it happens.) In the four most recent cycles, OFS stocks rose even more sharply, up an average of 55 percent off their lows by the time of the trough. “The magnitude to which the stocks have discounted a recovery by the time the rig count hits trough has been increasing over time,” say the strategists. But they also keep rising well after rig counts have bottomed out, delivering average returns of 5 percent in the six months following a trough and a full 29 percent over the course of a year. There wasn’t a single case in which stocks peaked before a rig count trough.

All of which brings us back to today. The U.S. oil rig count hit a low of 316 in late May. By August 12, it was up to 396. Those figures are still nowhere near the highs of 2014, but they’re high enough to prompt the equity strategists to be confident that a trough is indeed “firmly in the rear-view mirror.” But it’s only been three months post-trough, which suggests that investors can expect at least nine more months of positive returns from OFS stocks. In addition, OFS stocks have risen just 28 percent since their pre-trough lows, well below the historical average of 33 percent or the recent highs of 55 percent. Overall, the strategists say, “history suggests room to run.”

Credit Suisse suggests investors consider firms in growing OFS subsectors such as providers of proppant, a material key to hydraulic fracturing and shale production. The Bank also favors big companies that can afford to invest in technology that may not pay off immediately but could bring big dividends down the road. Substantial advancements in drilling technology since 2010 have allowed energy companies to get an oil well up and running faster than ever before—in the last six years, the number of days needed to drill a well has declined from 28 to 7 in some cases. The Bank believes innovation in oil production is next, with two leading OFS firms, Schlumberger and Halliburton, leading the way through “reservoir characterization models,” or technologies that help determine the best production techniques for a specific site. Such models help “wed” the firms to their clients, and the Bank’s strategists say it’s the kind of marriage oil-minded investors should keep an eye out for.

My career began in newspapers, with my byline appearing in The Boston Globe and The Providence Journal, among others. I started working in web journalism in 2008, reporting on business for ABC News and later founding the network’s parenting blog. I’m now a full-time business writer and editor.